Offshore Drillers: Pushed to the Brink by Sinking Oil Prices - Analyst Blog

The current oil price plunge – with crude tumbling 30% since June – provide the latest threat to the offshore drilling fraternity that is already facing a bleak industry outlook.

As the commodity enters into a bearish territory and flirts with the $75-a-barrel level, the top energy companies are expected to cut spending (particularly on the costly deepwater drilling projects) on the back of lower profit margins. This, in turn, means less work for the beleaguered drillers that are facing an uphill battle to turn around.  

Year-to-date, shares of major companies have significantly underperformed the broader market. In particular, stocks of Hercules Offshore Inc. (HERO), Transocean Ltd. (RIG), Diamond Offshore Drilling Inc. (DO) and Ensco plc (ESV) are down approximately 77%, 48%, 38% and 31%, respectively, while the broad-based S&P 500 index has gained 11% over the same period. Most are trading close to their 52-week lows. What's more, according to some analysts, the worst is still to come for these drillers.

The most pressing concern for the group, at least in the short-term, will be oversupply in the rig market. With large, multinational energy firms looking to reign in their skyrocketing capital expenses, the offshore drilling space is likely to see intense competition, as multiple firms chase a single contract. This excess capacity, in turn, could lead to lower utilization or dayrates.    

Secondly, the offshore contract drilling industry is perceived to be a highly cyclical one and the current thought is that rates had already peaked for this cycle back in late 2013. As the sector looks set to enter a cyclical downturn, drillers will prefer to hold on to their higher technology specification rigs, thereby significantly denting the company's fleet utilization and profitability.

Last but not least, while most of the drillers boast billion-dollar revenue backlogs, they are struggling with idled rigs – ones without contracts – in a slack market. On an average, just about two-thirds of available deepwater rigs for 2015 have been able to find customers. Even for this year, a number of drilling rigs remain uncontracted.  

Investors do not see an immediate rebound in the sentiment and expect more punishing times ahead with crude prices in a freefall. In particular, companies with a Zacks Rank #4 (Sell) or Zacks Rank #5 (Strong Sell) like Parker Drilling Co. (PKD), Vantage Drilling Co. (VTG) and Atwood Oceanics Inc. (ATW) look to be in the most trouble. These drillers have negative returns year to date and has been witnessing downward earnings consensus estimate revisions for the current quarter and year.